The U.S. House of Representatives on April 26th narrowly passed a bill to raise the debt ceiling, but the potentially market-rattling issue remains far from resolved.
The debt ceiling is the cap that Congress sets for the total amount of debt that the United States can accumulate. It was lifted to $31.4 trillion in December 2021. That cap was hit on January 19th of this year and since then the Treasury Department has been taking so-called "extraordinary measures" to avoid a government default. But those accounting measures are temporary and are expected to run out this summer, raising the pressure on Congress to raise or suspend the debt ceiling before a potential default that likely would be catastrophic for the economy.
Democrats and Republicans have been in a standoff over what to do since the limit was reached in January. President Joe Biden and congressional Democrats have insisted that they will support only a "clean" debt ceiling bill that has no strings attached. Republicans have said they will support only a debt ceiling increase that is paired with significant spending cuts. Biden met with House Speaker Kevin McCarthy (R-Calif.) on February 1st, but there have been no discussions about a compromise since then.
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The House action is designed to jumpstart negotiations. The Republican-controlled House approved a bill that would raise the debt ceiling by $1.5 trillion or until March 2024, whichever comes first. The bill would also cap fiscal-year 2024 federal spending at fiscal-year 2022 levels and would cap annual increases at 1% for the next decade. The Congressional Budget Office estimates that the package would result in about $4.8 trillion in spending cuts over the next 10 years, but Republicans have not specified exactly how those cuts would be implemented.
The House-passed bill, known as the "Limit, Save, and Grow Act," also includes a number of other provisions, including clawing back unspent funds designated to combat COVID-19; repealing about $71 billion of the $80 billion in increased funding for the IRS that Congress approved last year; repealing numerous green-energy provisions that were passed as part of the Inflation Reduction Act in 2022; blocking the president's plan to waive up to $10,000 in student debt from millions of borrowers; streamlining the permitting process for energy projects; and increasing work requirements for recipients of food stamps and Medicaid.
So what's next?
The spending cuts and other provisions make the bill a nonstarter in the Democrat-controlled Senate. Senate Majority Leader Chuck Schumer (D-NY) called the bill "dead on arrival" shortly after it was approved on a 217-215 vote in the House. Biden issued a veto notice and said that raising the debt ceiling was "not negotiable." Democrats would prefer to move the debate over spending and other issues to the annual budget process, which has its own deadline of September 30th.
House Republicans argued that the president and Senate Democrats need to come to the negotiating table now that the House is the only chamber to pass a bill to raise the debt limit. "We've done our job," McCarthy said after the vote.
Despite the tough talk, the two sides eventually will have to find a path forward. Senate Democrats, holding a narrow 51-49 majority, can't just pass a clean debt-ceiling increase, as that would likely be subject to a 60-vote supermajority to end a filibuster.
A key question is when the deadline for action is. In February, Treasury Secretary Janet Yellen told Congress that the Treasury would be unable to pay its bills as soon as early June. Other estimates of the "default date" have ranged from late June to early September. On April 26th, Goldman Sachs analysts said their calculations, based on April tax receipts, indicated that the default date would fall in late July.
Capitol Hill is waiting for Yellen to provide an official deadline, which should come soon. Having a specific timeline for when the ceiling must be raised undoubtedly will spur negotiations. But the path to a compromise remains as murky as ever.
One option under consideration is a short-term debt ceiling increase or suspension that would push the deadline out to perhaps the end of September. That would line the debate up with the annual government funding talks, buying Congress a couple of additional months for the difficult negotiations. But it's not clear yet what the appetite on Capitol Hill is for such a short-term fix.
Echoes of 2011
The markets are keeping a close eye on the debt ceiling debate, with worrisome memories of a similar standoff in 2011. That summer, Congress came the closest it has ever come to failing to act on the debt ceiling and pushing the country into a potentially catastrophic default. Notably, the political configuration in 2011 was the same as today: a Democrat in the White House, Democrats with a narrow majority in the Senate, and Republicans holding the majority in the House of Representatives.
As the 2011 stalemate unfolded, market volatility spiked. The S&P 500® index declined by more than 15% in a five-week period. And Standard & Poor's downgraded the U.S. credit rating for the first time in history. Market watchers fear a replay in 2023.
Already the markets are sending signals about investor concern. Treasury bills with maturity dates in mid-summer are seeing higher yields. And options traders are showing signs that they are anticipating increased volatility over the next few months.
The bottom line: Prepare for volatility
We continue to think the debt ceiling will be raised before the country defaults, but the battle is likely to go to the last minute and increased market volatility is likely. Congress has never failed to raise the debt limit, doing so nearly 80 times since 1960, under presidents of both parties and with different balances of power on Capitol Hill. Most analysts believe that the consequences of an unprecedented default would be devastating for the economy, which is a powerful incentive for the two parties to find a compromise. But the path to avoiding a default will require both parties to move off their hardline stances, and that is likely to take several more weeks.
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